Growth Company's current share price is $19.85 and it is expected to pay a $0.85 dividend...
Growth Company's current share price is $19.85 and it is
expected to pay a $0.85 dividend per share next year.
After that, the firm's dividends are expected to grow at a rate
of 3.7% per year.
a. What is an estimate of Growth Company's cost of equity?
b. Growth Company also has preferred stock outstanding that pays
a $1.90 per share fixed dividend.
If this stock is currently priced at $28.10, what is Growth
Company's cost of preferred stock?
c. Growth Company has existing debt issued three years ago with
a coupon rate of 6.3%.
The firm just issued new debt at par with a coupon rate of
6.4%.
What is Growth Company's cost of debt?
d. Growth Company has 4.7 million common shares outstanding and
1.2 million preferred shares outstanding,
and its equity has a total book value of $50.2 million.
Its liabilities have a market value of $20.1 million.
If Growth Company's common and preferred shares are priced as in
parts (a) and (b),
what is the market value of Growth Company's assets?
e. Growth Company faces a 38% tax rate.
Given the information in parts (a) through (d),
and your answers to those problems, what is Growth Company's
WACC?
Note: Assume that the firm will always be able to utilize its full interest tax shield.
Homework Answers
| a) | Cost of Company | |||||||
| = (D1 / P0) + g | ||||||||
| Where, | ||||||||
| D1 = Dividend of Next Year = $0.85 | ||||||||
| P0 = Current Share Price = $19.85 | ||||||||
| g = Expected Growth Rate = 3.7% = 0.037 | ||||||||
| So, | ||||||||
| Cost of Company | ||||||||
| = (D1 / P0) + g | ||||||||
| = ($0.85 / $19.85) + 0.037 | ||||||||
| = 0.0428 + 0.037 | ||||||||
| = 0.0798 | ||||||||
| i.e. 7.98% | ||||||||
| b) | Cost of Preferred Stock | |||||||
| = Fixed Dividend / Current Price | ||||||||
| = $1.90 / $28.10 | ||||||||
| = 0.0676 | ||||||||
| i.e. 6.76% | ||||||||
| c) | The Pre Tax Cost of Debt is the YTM of the Company on Current Debt. | |||||||
| Growth Company just issued new debt at par with Coupon Rate of 6.4%. | ||||||||
| So Coupon Rate will be the pre Tax Cost of Debt i.e. 6.4% | ||||||||
| Pre Tax Cost of Debt = 6.40% | ||||||||
| After Tax Cost of Debt | ||||||||
| = Pre Tax Cost of Debt*(1-Tax Rate) | ||||||||
| = 6.40%*(1-38%) | ||||||||
| = 6.40%*0.62 | ||||||||
| = 3.968% | ||||||||
| d) | Market Value of Company's Assets | |||||||
| = Marekt Value Debt + Market Value of Preferred Stock + Market Value of Common Shares | ||||||||
| = Marekt Value Liabilities + (No. of Shares*Current Stock Price) + (No. of Shares*Current Stock Price of Common Shares) | ||||||||
| = $20,100,000 + (1200000*$28.10) + (4700000*$19.85) | ||||||||
| = $20,100,000 + $33,720,000+ $93,295,000 | ||||||||
| = $147,115,000 | ||||||||
| e) | Market Weight Formula = Market Value of respective Source / Total Market Value | |||||||
| Source | Market Value | Market Weight Formula | Market Weight | Cost | Cost*Weight | |||
| Equity | $93,295,000 | = 93295000 / 147115000 | 0.6342 | 7.98% | 5.06% | |||
| Preferred Stock | $33,720,000 | = 33720000 / 147115000 | 0.2292 | 6.76% | 1.55% | |||
| Debt | $20,100,000 | = 20100000 / 147115000 | 0.1366 | 3.968% | 0.54% | |||
| $147,115,000 | 7.15% | |||||||
| WACC = 7.15% | ||||||||
|
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